R e g i s t e r e d O p t i o n s P r i n c i p a l Q u a l i f i c a t i o n E x a m i n a t i o n ( T e s t S e r i e s 4 )

Transcription

1 Registered Options Principal Qualification Examination (Test Series 4) Study Outline 2015 FINRA

2 Registered Options Principal Qualification Examination Series 4 Study Outline Introduction The Registered Options Principal (ROP) Qualification Examination is designed to test a candidate s knowledge of the rules and statutory provisions applicable to the supervisory management of a firm's options personnel and options accounts. This study outline, the examination question bank and question allocation have been developed by a committee of securities industry professionals with experience in the management of the brokerdealer s day-to-day options activities. This outline has been prepared to assist member firms in preparing candidates to sit for the examination. The outline is designed for use by course developers in the preparation of training material, for training directors in the development of lecture notes and seminar programs, and for use by the candidates themselves, both to structure their study and as a final review check list prior to sitting for the examination. A passing score will satisfy the qualification requirements of the Chicago Board Options Exchange, FINRA, NASDAQ OMX PHLX, NYSE Amex, and NYSE ARCA (jointly referred to as SROs) for a candidate who will function as a Registered Options Principal. The Registered Options Principal Qualification Examination and this study outline are composed of three general areas of supervision. These areas are specified below, accompanied by the number of questions that have been assigned to each section. Section General Area Number of Questions 1 Options Investment Strategies 34 2 Supervision of Sales Activities and Trading Practices 75 3 Supervision of Employees, Business Conduct, and Recordkeeping and Reporting Requirements 16 Total 125 Structure of the Examination The examination is composed of 125 multiple-choice questions covering all of the materials in the following outline in accordance with the subject-matter distribution shown above. Candidates will be allowed 3 hours and 15 minutes to complete the

3 examination. A candidate must correctly answer 70 percent of the questions to receive a passing grade. At the completion of the examination, each candidate will receive an informational breakdown of their performance on each section and their overall score. The examination is a closed-book test and candidates will not be permitted to use any reference material during their testing session. Scratch paper and a basic electronic calculator will be provided by the test center administrator. Severe penalties are imposed on candidates who cheat on securities industry qualification examinations. Examination questions are updated regularly to reflect the most current interpretations of the rules and regulations. To ensure that new questions meet acceptable testing standards prior to use, each examination includes 10 additional, unidentified "pre-test" questions that do not contribute towards the candidate's score. The 10 questions are randomly distributed throughout the examination. Therefore, each candidate takes a total of 135 questions, of which 125 questions are scored. Questions on new rules will be added to the pool of questions for this examination within a reasonable period of their effective dates. Unless a question is specifically asking about conventional OTC options, all questions should be read and answered as they apply to exchange listed standardized options. Also, unless a question is specifically worded to the contrary, all questions involving calculations exclude commissions and other transactions cost considerations. Information about qualifications examinations may be found at ualifications/index.htm There are also sample Series 4 test questions written in the various formats. They do not mirror the difficulty level of the actual test questions or the subject matter distribution of the test itself. Their use is merely to familiarize the candidate with the styles of multiplechoice questions used in the Series 4 Examination. The following reference materials may be used in preparing for the examination. Please Note: Candidates are responsible for keeping abreast of changes made to the applicable rules and regulations, as the examination is updated when new rules are introduced and/or amended. 2

4 Reference Materials While options rules are to a large extent uniform throughout the industry, trading floor procedures and operations requirements for conducting an options business vary slightly from exchange to exchange. Rule manuals and often options educational material may be obtained by contacting the following organizations: NYSE Amex Rules 20 Broad Street New York, NY Securities Act Handbook Aspen Publishers 111 Eighth Avenue New York, NY Chicago Board Options Exchange Constitution and Rules LaSalle at Van Buren Chicago, IL Code of Federal Regulations Title 17 Commodity and Securities Exchanges Superintendent of Documents U.S. Government Printing Office Washington, DC Dictionary of Finance and Investment Terms Barron s Educational Series, Inc. 250 Wireless Boulevard Hauppauge, NY NYSE ARCA Constitution and Rules 115 Sansome Street San Francisco, CA NASDAQ OMX PHLX Manual 1900 Market Street Philadelphia, PA Phone: (215) The Stock Market 7th Edition R.J. Teweles and E.S. Bradley John Wiley & Sons, Inc. 605 Third Avenue New York, NY Other publications available through: FINRA/NASD Rules FINRA Notices NASD Guide to Rule Interpretations NASD Sanctions Guidelines Options, Futures, and Other Derivative Securities J.C. Hull Prentice Hall Englewood Cliffs, NJ

5 1.0 Options Investment Strategies 1.1 Listed Options Understand terms and definitions of options products, investment strategies, and the inherent risks Apply knowledge of terms and definitions in supervising options transactions Equity Options Underlying securities Selection /withdrawal process Exercise settlement American European Expiration cycles Cycles vary Long-term equity anticipation securities (LEAPs) Strike price intervals Dependent upon the price of the stock Adjustment to option terms Cash dividends Stock dividends Stock splits Spin-offs Premiums Premium increments Factors affecting option premiums Expiration date Rule 1.1 Definitions FINRA Rule Rule 2360(a) Definitions Rule 4210 Margin Requirements (Definitions) Rule 1000 Applicability, definitions and references Rule 1010 Withdrawal of approval of underlying securities Rule (a) Series of options open for trading NYSE Rule Rule 700 Applicability, Definitions and References Rule 701 Option Contracts to Be Traded Rule 703 Series of Options Open for Trading Rule 716 Withdrawal of Approval of Underlying Stocks and Groups Rule 900 Applicability, definitions and references Flexible exchange options Rule 900G Applicability and definitions Rule 903G Terms of flex options Rule 904G Flex trading procedures and principles NYSE ARCA Rule Rule 6.1(a) Options trading, definitions 4

6 1.1.2 Index Options Broad-based index Narrow-based index Exchange traded funds (ETFs) Industry-based index Exercise style By cash payment on the next business day Settlement amount is the difference between strike price and index closing value Expiration cycles Cycles vary LEAPs Flexible Exchange options (FLEX) Strike price intervals Premium increments Expiration date Exercise assignment European American Chapter XXIV Index options Rule 1006 Order restrictions on exchange option transactions and exercises Rule 1101A(a) and (ii) Terms of option contracts Rule 700(b)(2A) American-Style Index Options Rule 700(b)(19) European-Style Index Options Rule 703(c) Expiration Months Index Options Rule 900C Stock index options NYSE ARCA Rules Rule 5.10 Index options Foreign Currency Options Contract sizes Expiration cycles Expiration date Settlement style American style European style Trading hours Strike price intervals Premium increments Rule 1000(b)(13) Definitions foreign currency Rule 1012(a)(ii) Foreign currency options series Rule 1016 Block transactions in foreign currency options 5

7 1.2 Strategy Investment Posture for Various Market Scenarios and Their Tax Implications Assist Registered representatives in formulating investment strategy for customers Identify uneconomic trades Understand investment strategies Strategies for Using Puts or Calls Call buying strategies Alternative to buying the underlying security To lock-in a purchase price To hedge a short sale Put buying strategies To hedge a long position Alternative to short sale Covered call writing concepts Increase yield Hedge a position Put writing concepts Increase income Acquire stocks below current prices Types of Spread Bull spread Bear spread Time spread Diagonal spread Variable spread Butterfly spread Straddle Strategies Based on Market Outlook Neutral Covered call writing (at market) Straddle writing Combination writing Bullish Covered call writing (above market) Uncovered put writing Call purchasing Long stock/long put Bull spreading Bearish Uncovered call writing Put purchasing Bear spreading Other Strategy Considerations Synthetic positions Long stock/short call = short put Short stock/long call = long put Short stock/short put = short call Long call/short put = long stock Long stock/long put = long call 6

8 Short call/long put = short stock 1.3 Calculation of Profit, Loss and Break-even Know how to calculate profit, loss and breakeven points of various strategies Ability to calculate profit, loss and breakeven limits and amounts at expiration of aggregate positions relative to movements in the underlying security - percentage return (loss) Limits will fluctuate from time of recommendation to time of close-out or expiration 1.4 Taxation Understand tax implications of options transactions Understand wash sales and their impact on customer accounts General Concepts Identification of securities Holding periods of securities Wash Sale rules Tax treatment of short options Determination of cost basis Determination of taxable event Cabinet trading Tax Treatment of Options Options purchased by investors Subsequent sale of options Expired options Exercised call options Exercised put options Options written by investors Short-term gain or loss Expired options Exercised put options Exercised call option Subsequent purchase of options Tax treatment of long straddles and combinations 7

9 2.1 Supervision of Account Activities 2.0 Supervision of Sales Activities and Trading Practices Supervise RR and customer activities relating to options Ensure that Registered Options Principal designated by the member firm s written supervisory procedures (WSP) reviews the acceptance of each options discretionary account Ensure that Registered Options Principal designated by the member firm s WSP provides frequent appropriate supervisory review Ensure that discretionary option orders are approved and initialed on the day entered Ensure that options programs are in writing Establish written supervisory procedures Ensure that branch office manager reviews all correspondence Supervisory Procedures Written policies and procedures Supervisory reviews Account approvals Training Transactions with issuers Members may not accept transaction for sale (writing) of call options for issuer of underlying security Determination that necessary appropriate documentation is on file Level of trading Must specify the delineation of supervisory responsibilities within the firm for specific tasks Must establish separate review procedures to insure that delegated authority is being properly exercised Rule 9.8(a) Supervision of accounts; Interpretation.01 Rule 2360(b)(20) Supervision of Accounts Rule 3110 Supervision Rule 3120 Supervisory Control System Rule 3130 Annual Certification of Compliance and Supervisory Processes Rule 3160 Networking Arrangements Between Members and Financial Institutions Rule 3170 Tape Recording of Registered Persons by Certain Firms NASD Rules Rule 3010(e) Qualifications Investigated Rule 3010(f) Applicant s Responsibility Rule 748 Supervision Rule 761 Supervisory procedures Rule 1025 Supervision of accounts Rule 342(a) and (d)(3) Offices Approval, Supervision and Control Rule 343 Offices Branch Office Space-Sharing Arrangements and Main Office Business Hours 8

10 Rule 722 Supervision of Accounts Rule 320 Offices approval, supervision and control Rule 921(g) Written procedures Rule 922(a) Duty to supervise, designation of supervisory personnel Rule 922 Commentary.01 Supervision of accounts Rule 991 Communications to customers NYSE ARCA Rules Rule 9.1(c) Office Supervision Rule Supervision Account-Related Communications With Customers Confirmations to customers Rule 9.11 Confirmation to customers Rule 2360(b)(12) Confirmations Rule 1028 Confirmations Rule 725 Confirmations Rule 925 Confirmations Securities Exchange Act of 1934 Rule 10b-10 Confirmation of transactions Statements of accounts to customers Rule 9.12 Statements of accounts to customers FINRA Rule Rule 2360(b)(15) Statements of account NASD Rule Rule 2340 Customer Account Statement Rule 1032 Statements of Accounts Rule 409 Statement of Accounts to Customers Rule 730 Statement of Accounts Rule 930 Statement of accounts NYSE ARCA Rules Rule 9.15 Statements of accounts to customers Securities Exchange Act of 1934 Rule 17a-5(c) Customer statements Statements of financial condition to customers Rule 9.13 Statement of financial condition to customers Rule 2261 Disclosure of Financial Condition 9

11 Rule 442 Disclosure of financial condition to customers Anti-money laundering compliance program Rule 4.20 Anti-money laundering compliance program Rule 3310 Anti-Money Laundering Compliance Program Rule 757 Anti money laundering compliance program Rule 432 Anti-money laundering compliance program Offer and sale of new issue securities indications of interest Rule 5130 Restrictions on the Purchase and Sale of Initial Equity Public Offerings 2.2 Supervising Options Sales Practices Supervise sales practice activities of registered representatives as they assist their customers in buying and writing options Conduct suitability review to ensure use of options is consistent with client profile Understand written supervisory procedures, application and adherence thereto Understand documentation requirements for options accounts Ensure compliance with firm's written supervisory procedures for trading of options Ensure that complaints are segregated and forwarded to main office within prescribed time Review account documentation for completion Review to ensure customer verification within 15 days of ROP approval and receipt of signed options agreement Ensure options disclosure document is delivered at or prior to account approval Provide special statement for uncovered writers Ensure that accounts approved for uncovered options transactions meet the firm s internal standards for approval Understand minimum net equity requirements for approval and maintenance of uncovered transactions Ensure that any exceptions are approved and evidenced by a Registered Options Principal designated by the firm s written supervisory procedures Client Account Documentation Types of customer accounts Individual customer Joint customer Corporate customers Partnership accounts Fiduciaries Trust accounts Qualified retirement accounts Investment advisory accounts Institutional discretionary accounts 10

12 Options new account form Limited authorization Full authorization Discretionary Client profile Terms of approval Account approval based on evaluation of client profile Approval required not later than the time an initial option order is accepted for the account Branch office manager approval Options accounts must be approved for only certain strategies Copy of background and financial data must be sent to customer for verification within 15 days after approval New account form must be retained at both the branch office and the principal supervisory office Account approval for foreign currency options Rule 9.7(b) Diligence in opening account Rule 9.10(a) Authorization and approval required Rule 9.10(e) Options programs Rule 9.14 Addressing of communications to customers Rule 2090 Know Your Customer Rule 2360(b)(16)(B) Diligence in opening accounts NASDAQ OMX PHLX Rule Rule 1024 Diligence in opening accounts Rule 1024(b)(iii) Verification of customer background and financial information Rule 1049 Communications to customers Rule 721 Opening of Accounts Rule 726 Delivery of Options Disclosure Document and Prospectus Rule 421 Discretion as to customer s accounts Rule 921(c) Diligence in openings Rule 922 Supervision of accounts NYSE ARCA Rules Rule 9.2(a) Diligence as to accounts Rule 9.2(b) Account supervision Rule 9.2(c) Customer records Rule 9.18 Doing public business in options Other supplementary account documentation and customer verification Hypothecation and loan consent agreement Margin agreement Credit terms disclosure Third party trading authorization Signed option account agreement Risk disclosure document Account guarantee acknowledgment Information required for institutional customers engaging in foreign currency options 11

13 Escrow receipts, bank letters of guarantee, depository trust receipts or other special collateral arrangements Requirements regarding accounts of deceased/incompetent persons Transfer on Death (TOD) Account Outstanding orders Cancellation Freeze on assets in account Fiduciary treatment of positions Death of a joint tenant Death of tenant-in-common Death of a partner Death of a principal on a power of attorney Rule 9.7(d) Agreements to be obtained Rule 9.15 Delivery of current options disclosure documents Rule 9.16 Restrictions on pledge and lending of customers securities Rule 12.8 Guaranteed accounts Rule 2360(b)(16)(C) Verifications of customer background and financial information Rule 4210 Margin Requirements Rule 256 Option risk disclosure Rule 724 Guaranteed accounts Rule 1024(b)(iii) Verification of customer background and financial information Rule 1024(b) Opening accounts Rule 1024(b)(iv) Agreements to be obtained Rule 721(c) Verifications of Customer Background and Financial Information Rule 721(d) Agreements to Be Obtained Rule 411 Duty to know and approve customers Rule 413 Agreement does not warrant delivery of customer s securities for firm or corporation account Rule 462(d)(2)(K)(4) Guaranteed accounts Rule 921(d) and Commentary.03 Verifications of customer background and financial information Rule 921(e) Agreements to be obtained Securities Exchange Act of 1934 Rule 10b-16 Disclosure of credit terms in margin transactions Regulation S-P Privacy of consumer financial information Discretionary accounts authorization and approval Records to be maintained Excessive transactions prohibited Discretion as to time or price excepted Options programs Supervision 12

14 Rule 9.10 Discretionary accounts Rule 2360(b)(18) Discretionary accounts Rule 1027 Discretionary accounts Rule 408 Discretionary Power in Customers Accounts Rule 724 Discretionary Accounts Rule 924 Discretionary accounts Securities Exchange Act of 1934 Rule 15c1-7 Discretionary accounts Options programs Rule 9.10(e) Options programs Rule 2360(b)(18)(C) Options Programs NASDAQ OMX PHLX Rule Rule 1027(b) Options programs Rule 724(b) Options Programs Rule 924(b) Options programs Minimum net equity requirements Rule 9.7(f)(4) Opening of accounts Rule 4210 Margin Requirements Rule 721(e)4 Uncovered Short Option Account Rule 921(g)(4) Minimum net equity requirements Special statement for uncovered writers Rule 9.7(f)(5) Opening of accounts Rule 9.15(c) Delivery of current options disclosure documents and prospectus Rule 2360(b)(16)(E) Uncovered short option contracts Rule 1029 Delivery of options disclosure documents and prospectus Rule 721(e)5 Uncovered Short Option Accounts Rule 726(c) Uncovered Short Options Risk Disclosure Rule 921(g)(5) Special written description of the risks 13

15 Uncovered options transactions Rule 921(g) and Commentary.04 Written procedures Rule 9.7(f) Opening of accounts Rule 9.8(a) Duty to supervise Rule 2360(b)(7) Limit on uncovered short positions Rule 1024(c) Uncovered options supervision Rule 721(e) Uncovered Short Option Accounts NYSE ARCA Rules Rule 6.18 Limits on uncovered short options Suitability Assist registered representatives in helping customers formulate investment objectives and to set financial goals Review trading and suitability of trade activity, e.g., use of margin, day trading or concentrated positions and/or excessive transactions Review for initial and ongoing suitability of various investment portfolios and objectives Review managed accounts to ensure that the investment styles of the advisers and managers are consistent with the objectives of the customer Ensure that registered representatives have necessary product knowledge Ensure suitability of recommending options strategies Ensure that registered representatives understand suitability requirements Suitability of recommendations Clear understanding of customer's investment objectives Need for customer understanding of strategies Customer s understanding of and ability to assume financial risk/loss Potential for excessive transaction costs Consequences of exercise Tax implications Margin implications Investment risks relative to customer's total portfolio Substitution problems Restrictions on profit sharing Prohibition on assuming losses Rule 9.9 Suitability of recommendations Rule 2111 Suitability Rule 2360(b)(19) Suitability Rule 1026 Suitability 14

16 Rule 721(e) Uncovered short options accounts Rule 723 Suitability Rule 923 Suitability 2.3 Communications with the Public Supervise registered representatives' use of options advertisements, sales literature and educational material Ensure that all advertisements, educational material and sales literature are approved in advance by the Registered Options Principal designated by the firm s written supervisory procedures Review and approve options sales literature and educational material Ensure compliance with recordkeeping and record retention requirements Ensure that options materials comply with SRO requirements Review and approve public seminars and presentations Monitor the use of internal use only sales material Monitor telemarketing procedures, e.g., maintain do not call list Maintain a log of public seminars and presentations given by registered representatives Definitions Advertisement Educational material Sales literature Market letters Research reports Internal communications Exchange-produced materials Seminar texts Worksheets Telemarketing scripts Correspondence Institutional sales material Rules 9.21 (e)(i), (ii), (iii) Definitions Rule 2210 Communications with the Public Rule 2220(a) Definitions NASD Rules Rule 2711(a) Definitions Rule 605 Advertisements, market letters, research reports and sales literature Rule 1049(e) Communications to customers Rule 472 Communications With The Public Rule 791(e) Communications to Customers, Definitions Rules 991 (e)(i), (e)(ii), (iii) Definitions 15

17 2.3.2 Required Approval Approval by designated ROP Rule 9.21(b) Approval by Registered Options Principal Rule 2220(b) Approval by a Registered Options Principal and Recordkeeping NASD Rules Rule 2711(i) Supervisory Procedures Rule 1049(b) Approval by a CROP Rule 791(b) Approval by Compliance Registered Options Principal Rule 991(b) Required approval by a CROP SRO approval requirements Rule 9.21(c) Exchange approval required for options advertisements and educational material Rule 2220(c) FINRA Approval Requirements and Review Procedures Rule 1049(c) Exchange approval required for options advertisements and educational material Rule 791(c) Exchange Approval Required for Options Advertisements and Educational Material Rule 991(c) Exchange approval required for options advertisements and educational material Guidelines and standards of approval In the case of "option programs" the cumulative history or unproven nature and underlying assumptions must be disclosed Worksheets must conform to sales literature requirements Such communications must be kept in an easily accessible place for a period of three years Prohibitions against: Untrue statements and material omissions Promises of specific results or exaggerated claims Hedge clauses Disclaimers Failure to meet general standards of good taste and truthfulness Communications that would constitute a prospectus Rule 9.21 Communications to customers Rule Special risks Rule Advertisements Rule Educational Material 16

18 Rule Sales Literature Rule 2220(d) Standards Applicable to Communications Rule 1049(a) Communications to customers Rule 791(a) Communications to Customers, General Rule Rule 991(a) Communications to customers, general rules NYSE ARCA Rules Rule 9.28 Advertisements, market letters and sales literature relating to option Options Disclosure Documents Delivery requirements Must be offered in advertisements and educational material Must precede or accompany sales literature Rule 9.7(e) Options disclosure documents to be furnished Rule 9.21(d) Communications to customers Rule 2360(b)(11) Delivery of current disclosure document Rule 1029 Delivery of options disclosure document and prospectus Rule 1049(d) Communications to customers Rule 791(d) Options Disclosure Document Required Rule 921 (f) options disclosure document to be furnished Rule 926 Delivery of options disclosure document and prospectus Rule 991(d) Delivery of disclosure documents Telemarketing Requirements Rule 9.24 Telephone solicitation Rule 3230 Telemarketing Rule 762 Telemarketing Rule 428 Telephone solicitation--recordkeeping Rule 429 Telemarketing 2.4 Federal Regulations Pertaining to Sales Practices Securities Act of Section 2 Definitions under the Act Rule 134 Communications not deemed a prospectus Interpretations as applied to options of the OCC 17

19 Rule 144 Persons deemed not to be engaged in a distribution and therefore not underwriters Rule 145 Reclassification of securities, mergers, consolidations and acquisitions of assets Section 5 Prohibitions Relating to Interstate Commerce and the Mails Rule 135 Notice of certain proposed offerings Rule 135A Generic advertising Use of "worksheets", "substantially identical" letters, "prospecting" letters Rule 153(b) Definition of preceded by a prospectus, as used in Section 5(b)(2), in connection with certain transactions in standardized options Securities Exchange Act of Section 3 Certain definitions under the Act Exchange Member Broker Dealer Issuer Security Equity security Buy-Purchase Sale-sell Clearing agency Section 9 Prohibition Against Manipulation of Security Prices Section 9(a)(1) Misleading appearance of active trading Section 9(a)(2) Inducing purchase of sale by others Section 9(a)(3) Dissemination of information as to rise or fall of securities prices Section 9(a)(4) Making false or misleading statements Section 9(a)(5) Dissemination of information for consideration Section 9(a)(6) Pegging, fixing or stabilizing prices Section 9(b) Options disclosure document Section 9(e) Liability for unlawful acts or transactions Section 10(b) Use or Employment of Deceptive Devices Rule 10b-3 Employment of manipulative and deceptive devices by brokers or dealers Rule 10b-18 Purchases of certain equity securities by the issuer and others Regulation 14E Tender offers Rule 14e-4 Prohibited transactions in connection with partial tender offers Regulation M Antimanipulation Rules Concerning Securities Offerings Rule 101 Activities by distribution participants Rule 102 Activities by issuers and selling security holders during a distribution Rule 103 NASDAQ passive market making Rule 104 Stabilizing and other activities in connection with an offering Rule 105 Short selling in connection with a public offering 18

20 Regulation FD Fair disclosure Requirement that when an issuer discloses material nonpublic information to certain persons (such as, securities market professionals and holders of the issuer's securities who may well trade on the basis of the information), it must make public disclosure of that information Enhancement of existing prohibitions against insider trading Insider Trading Insider Trading and Securities Fraud Enforcement Act of 1988 Section 3 Civil penalties of controlling persons for illegal insider trading by controlled persons Rule 4.18 Prevention of misuse of material, nonpublic information Rule 761 Supervisory procedures relating to Insider Trading and Securities Fraud Enforcement Act of 1988 Rule Trade Review and Investigation Rule 351(e) Reporting Requirements NYSE ARCA Rules Rule 11.3 Prevention of misuse of material, nonpublic information Securities Exchange Act of 1934 Section 15(f) Registration and regulation of brokers and dealers written policies and procedures relating to misuse of material, non-public information Rule 10b-5 Employment of manipulative or deceptive devices Rule 10b5-1 Trading on the basis of material nonpublic information in insider trading cases Rule 10b5-2 Duties of trust or confidence in misappropriation insider trading cases 2.5 Extensions of Credit in the Securities Industry Understand margin implications associated with various strategies Understand minimum margin requirements set by regulation for initial/maintenance requirements Recognize that firms and/or exchanges may set higher requirements Obtain documentation related to margin agreement Understand margin calculations Know how to calculate initial/maintenance/variation call Understand mark to market to calculate amount of call Know what is required to meet margin call daily Know the acceptable collateral deposits Understand margin strategy offsets under FINRA Rule 4210 Review customer accounts/transactions to ensure compliance with short sale and buy-in rules General Margin Requirements Long accounts 19

21 Regulation T Spread Any options position having both long options and short options of the same type on the same underlying instrument; for a spread to qualify for margin, the long must expire prior to the short position Uniform options margin requirements: Initial requirement Maintenance call Short accounts Federal initial requirements for short sales Maintenance margin requirements for short sales Margin substitutions Same day substitutions Adjusted debit balance Withdrawal of dividend and interest credit Chapter XII Margins Rule 4210 Margin Requirements Rule 4210 (f)(2) Puts, Calls and Other Options Rule 721 Proper and adequate margin Rule 722 Margin accounts Rule 700(b)(14) Covered - Short Positions Rule 772 Option Contracts of Suspended Members Rule 462 Minimum margins Securities Exchange Act of 1934 Regulation T Section 7 Margin requirements Section 8 Restrictions on borrowing by members, brokers and dealers Other Provisions of Regulation T General rule Prompt payment Extensions of time Cash accounts Escrow Agreements Letters of guarantee Depository trust receipts Short Sales and Mandatory Buy-ins NASD Rules Rule Buying-In 20

22 2.6 Trading Practices Rule 455 Short sales Rule 440B Short Sales Rule 440C Short Sale Borrowing and Delivery Requirements Rule 7 Short sales Rule 784 Mandatory closing of fails Securities Exchange Act of 1934 Regulation SHO Short sales Rule 200 Definition of short sale Rule 201 Price test and marking requirements Rule 203 Borrowing and delivery requirements Rule 15c3-3(h) Customer Protection reserves and custody of securities Understand when and why a trading rotation and fast markets will be utilized Understand the roles and responsibilities of market participants Comply with relevant position/exercise limits Ensure appropriate aggregation of accounts for reporting position limits, exercise limits, and large positions Understand contract adjustment due to such events as splits, mergers, dividends Review orders to ensure they are eligible for electronic order routing/execution Review orders to ensure that orders are not "unbundled Terms and Definitions Rule 6.45 Priority of bids and offers allocation of trades Rule 6.70 Floor broker defined Rule 8.1 Market maker defined Rule 8.80 DPM defined Rule 900.1NY Applicability, definitions and references Rule 950(d) Precedence of bids and offers NYSE ARCA Rules Rule 6.52 Obligations for orders Trading Rotation Opening Closing Business day prior to expiration Intra-day Re-open after halt Rule 6.2 Trading rotations Rule 6.2A Rapid opening system Rule 6.2B Hybrid opening system Rule 1047 Trading rotations, halts and suspensions 21

23 Rule 717 (a) Trading Rotations Rule 1 Commentary.02 Hours of business (Trading rotation) Rule 918 (a) Trading rotations Rule 918 Commentary.01,.02,.03 and.04 Rule 918C(a) Supervision of trading Rule 918C Commentary.03,.04,.05 and.06 (Trading rotations) NYSE ARCA Rules Rule 6.64 Trading rotations Fast Markets and Trading Halts Rule 6.3 Trading halts Rule 5260 Prohibition on Transactions, Publication of Quotations, or Publication of Indications of Interest During Trading Halts Rule 6120 Trading Halts Rule 1047 Trading Rotations, Halts and Suspensions Rule 717 (b) Trading Halts or Suspensions Rule 918 Trading halts Rule 918(b) Trading halts Rule 918 Commentary.05 Delayed openings Rule 918(c) Supervision of trading Rule 958A(d) Application of the firm quote rule use of unusual market exception NYSE ARCA Rules Rule 6.65 Trading halts and suspensions Position and Exercise Limits : Rule 4.11 Position limits Rule 4.12 Exercise limits Rule 24.4 Position limits for broad-based index options Rule 24.4A Position limits for industry index options Rule 24.5 Exercise limits Rule Exercise of American style index options Rule 2360(b)(23)(A) Exercise of options contracts Rule 2360(b)(4) Exercise limits Supplementary Material.01 Position limit examples Rule 1001 Position limits Rule 1001A Position limits options on indices Rule 1002 Exercise limits Rule 704 Position Limits Rule 705 Exercise Limits Rule 904 Position limits 22

24 Rule 904C Position limits stock index options Rule 904D Position limits T-Bill options Rule 904D Exercise limits T- Bill options Rule 905 Exercise limits Rule 905C Exercise limits stock index options Rule 906G Position Limits Flexible exchange options Rule 907G Exercise Limits Flexible exchange options Rule 980 Exercise of options contracts NYSE ARCA Rules Rule 6.8(a) Options Trading, Position limits Rule 6.9 Options trading, exercise limits Rule 6.11 Exercise of options contracts Contract Adjustments Rule 5.7 Adjustments Rule 703(g) Contract Adjustments Exchange Order Routing Systems Rule 6.8 RAES Operations Rule 60 Responsibility for PER and AMOS orders, subparagraph (a) Types of orders Market orders Limit orders Stipulation Day GTC Market not held Stop limit Spread Straddle Combination Contingency Immediate-or-cancel At the close Rule 6.53 Certain types of orders defined Rule 1066 Certain types of orders defined Rule 123A Miscellaneous Requirements Rule 131 Types of orders Rule 131A Market on the close policy and expiration procedures Rule 950(e) Types of orders 23

25 2.7 Exercise/Assignment of Options Understand the mechanics and ramifications of the tendering of exercise notices for options; exercise by exception and same day exercise Understand the effect of exercise prior to ex-dividend date Understand applicable time limitations Understand the mechanics and effects of assignment, particularly on ex-dividend date Understand OCC assignment procedure and firm/market maker/customer assignment Understand firm procedures for allocating customer assignments (FIFO, random) Ensure customer notification of allocation method Ensure compliance with requirement for delivery and payment/settlement Understand priority offered orders Understand time priority Understand off-floor accommodations and the necessary reporting obligations Tender of Exercise Notices Equity options Effect of exercise prior to ex-dividend date Time limitations Same day exercise Exercise by exception Index options Foreign currency options Rule 11.1 Exercise of option contracts Rule 2360(b)(23) Tendering procedures for exercise of options Rule 1042 Exercise of equity option contracts Rule 1042A Exercise of option contracts options on indices Rule 980 Exercise of options contracts Assignment of Exercise Notices Effect of assignment on ex-dividend date of equities OCC assignment procedure Firm/market maker/customer assignment Acceptable procedures for allocating customer assignments Allocation methods Delivery and payment /settlement date Workpapers and documentary materials regarding assignment notices Rule 11.2 Allocation of exercise notices Rule 11.3 Delivery and payment Rule 2360(b)(23)(C) Allocation of exercise assignment notices 24

26 Rule 1043 Allocation of exercise notices Rule 781 Allocation of Exercise Assignment Notices Rule 981 Allocation of exercise notices Rule 982 Delivery and payment NYSE ARCA Rules Rule 6.25 Allocation of exercise assignment Obligations of Floor Personnel Specialists Order Book Official (OBO) Market makers/ Registered Option Traders (ROT's) Limited Trading Permits (LTP's for indices only) Designated Primary Market Maker (DPM) Lead Market Maker Agency capacity Principal capacity Cabinet trading Supervision of specialist/obo.01 per lot Time priority Not reported to vendors Off-floor accommodations Rule 6.54 Accommodation liquidations Rule 6.73 Responsibilities of floor brokers Rule 8.4 Remote market makers Rule 8.8 Restriction on acting as market maker and floor broker Rule 8.85 DPM obligations Rule 2360(b)(24) Options transactions and reports by market makers in listed securities Rule 1059 Accommodation transactions Rule 756 Transaction off the Exchange Rule 759 Accommodation Transactions Rule 950(f) Orders left with specialist Rule 950(g) Representation of orders Rule 950(n) Registration and functions of specialists Rule 958 Options transactions of registered traders Rules 959 Accommodation transactions NYSE ARCA Rules Rule 6.37 Obligations of market makers Rule 6.46 Responsibilities of floor brokers 25

27 2.8 Clearance, Transaction Review and Settlement Procedures Ensure registered representatives understand and are able to explain to customers the settlement procedures, e.g., prompt receipt and delivery, affirmative determination, denominations of delivery, assignments, ex-dividend transactions, etc. Ensure proper documentation is obtained for settlement Ensure proper handling of customer requests to transfer accounts Review erroneous transactions for proper resolution OCC Clearance Procedures Daily Position Report Trades compared from previous business day Net premium balance due to or from OCC for all settled transactions All exercises and assignments All daily activity Daily Margin Report Amount of margin on deposit, amount of margin required, margin excess or deficit, acceptable forms of margin Underlying stock Un-segregated long positions (spread margin) Cash or equivalent, T-bills, Letter of Credit Depository Record Advisory In-the-Money Report Transaction Review Position adjustments Trade adjustments form Unmatched adjustment report Types of errors Account type errors (firm/customer) Trade type error (open/close) Rule 6.52 Price binding despite erroneous report Rule Clearly Erroneous Transactions Rule 152 Taking or supplying stock to fill customer s order Rule 731 Resolution of uncompared transactions Rule 958NY Price Binding Despite Erroneous Report Rule 970 Comparison of option transactions excluded from clearance NYSE ARCA Rules Rule 6.70 Price binding despite erroneous report 26

28 2.8.3 Settlement Practices Settlement and delivery requirements NASD Rules Rule Assignments and powers of substitutions; Delivery of registered securities Rule Certificate in name of deceased person, trustee, etc. Rule COD Orders Rule 1044 Delivery and payment Rule 198 Signatures Rule 199 Corporate Assignments Rule 200 Assignments - By Member Organizations Rule 201 Assignments - By Persons Since Deceased, Trustees, Guardians, etc. Rule 207 Two or More Names National Medallion Signature Guarantee Program Rule 752 Failure to deliver Rule 753 Payment on delivery Rule 982 Delivery and payment Account transfer requirements Rule 9.20 Transfer of accounts Rule 2140 Interfering with the Transfer of Customer Accounts in the Context of Employment Disputes NASD Rules Rule Customer Account Transfer Contracts Rule 412 Customer account transfer contracts 27

29 3.0 Supervision of Employees, Business Conduct, and Recordkeeping and Reporting Requirements 3.1 Hiring, Qualifications and Continuing Education Ensure that registered representatives Form U4s are current Ensure that state registration requirements for agents and investment advisers are met Ensure that registered representatives are adequately trained with respect to options Initiate pre-hire investigations Review new employees previous registration and work history Supervise registered representatives compliance with Continuing Education requirements Qualification and Registration Requirements 3.l.1.1 Registered Representative (RR) Persons required to be registered Terminations General Securities Sales Supervisor (BM or SU) Persons required to be registered Limitations on principal supervisory function Registered Options Principal (ROP) Persons required to be registered Terminations Rule 9.2 Registration of Options Principals Rule 9.3 Registration and termination of representatives Rule 9.6(b) Branch offices of member organizations Rule 9.8 Supervision of accounts FINRA By-Laws Article III, Section 3 Ineligibility of certain persons for membership or association Article V, Section 1 Qualification requirements NASD Rules Rule 1022(f) Limited Principal - Registered Options and Security Futures Rule 1032(d) Limited Representative - Options and Security Futures Rule 604 Registration and termination of registered persons Rule 1024(a)(i) Registration of options principals Rule 1024(a)(iii) Foreign currency options qualified customer personnel Rule 345 Employees Registration, Approval, Records Rule 347 Controversies as to Employment or Termination of Employment 28

30 Rule 351 Reporting Requirements Rule 720 Registration of Options Principals Rule 722(a) Supervision of Accounts, Duty to Supervise: SROP Rule 722(b) Compliance Registered Options Principal Rule 920 Registration and examination of options personnel - Options principal NYSE ARCA Rules Rule 9.26 Registration of Options Principals Rule 9.18 Doing public business in options Rule 9.27 (a) Registration of Representatives Special Registration Review for Disciplinary History Statutory Disqualification Rule 3.18 Members and associated persons who are or become subject to a statutory disqualification FINRA By-Laws Article 3 Sec.4 Definition of disqualification Rule Investigation and Records Rule 310(d) Formation of or admission to member organization or membership owner Rule 341B Independent contractors Rule 342(e) Association of members, member organizations, and persons associated with member organizations Rule 353 Amex Trading Permit Requirements Rule 356 Member organizations Securities Exchange Act of 1934 Sec. 3(a)(39) Definition of statutory disqualification Continuing Education for Registered Persons Regulatory element Rule 9.3A(a) and (b) Regulatory element Rule 1250 Continuing Education Requirements Rule 345A(a) Regulatory Element Rule 640(a) Regulatory element Rule 341A(a) Regulatory element NYSE ARCA Rules Rule 9.27(c) Regulatory element Firm element Rule 9.3A(c) Firm element 29

31 Rule 1250 Continuing Education Requirements Rule 640(b) Firm element Rule 345A(b) Firm Element Rule 341A(b) Firm element 3.2 General Supervision Conduct of Associated Persons Ensure compliance with firm written supervisory procedures and systems Monitor registered representatives activities regarding gifts and gratuities Review possible outside business activities of registered representatives obtain necessary approvals Review for possible private securities transactions by registered representatives (selling away) Review registered representatives accounts and employee-related accounts held at other firms ensure necessary approvals are obtained, review confirmations and statements Monitor trading activities for possible selling away Review customer accounts to determine that registered representatives are properly handling customer securities or funds Prevent improper use of customer assets Monitor and document third party transfer of securities or funds Monitor entry and allocation of block orders Ensure correct entry and handling of orders Review employee related accounts for any irregularities Review customer accounts to ensure that investments are consistent with stated objectives and risk tolerance Ensure that proper disclosures are made regarding nature of securities sold to a customer Business Conduct Rule 4.1 Just and equitable principles of trade Rule 2010 Standards of Commercial Honor and Principles of Trade NASD Rules Rule 2420 Dealing with non-members Rule 707 Just and equitable principles of trade Rule 401 Business Conduct Rule 435(1) Miscellaneous Prohibitions Rule 16 Business conduct Article V, Section 4(h) Violation of constitution, rules or resolution- inequitable conduct Gifts and Gratuities Rule 4.4 Gratuities 30

32 Rule 3220 Influencing or Rewarding Employees of Others Rule 347 Gratuities to employees of financial concerns Outside Business Activities Rule 9.4 Other affiliations of registered associated persons Rule 3270 Outside Business Activities of Registered Persons NASD Rules Rule 3040 Private Securities Transactions of an Associated Person Rule 342 Association of members, member organizations and persons associated with member organizations Non-cash Compensation Rule 5110(e) Valuation of non-cash compensation Rule 5110(i) Non-cash compensation Sharing in Customer Accounts Rule 9.18 Guarantees and profit sharing Rule 9.19 Assuming losses Rule 2150 Improper Use of Customers Securities or Funds; Prohibition Against Guarantees and Sharing in Accounts Rule 352 Guarantees, Sharing in Accounts, and Loan Arrangements Rule 390 Assumption of loss prohibited Transactions with Customers Rule 9.25 Borrowing from or lending to customers Rule 3240 Borrowing From or Lending to Customers Transactions with Other Professionals Rule 9.17 Transactions of certain customers NASD Rules Rule 3050 Transactions For or By Associated Persons NASDAQ OMX Rules Rule 751 Accounts of employees of members of participating organizations Rule 407 Transactions of Employees of Members, Member Organizations and the Exchange Rule 407A Disclosure of All Member Accounts Rule 415 Member s transactions with another member organization 31

33 3.3 Customer Complaints Review and investigate customer complaints (oral and written) Document and keep records of customer complaints Ensure that complaints are forwarded to main office within prescribed time frames Comply with firm and SRO reporting requirements Ensure that options related complaints are segregated and forwarded to main office within prescribed time Handling Customer Complaints and Reporting Requirements Complaints must be kept in a central file/log Branch offices must forward complaint to the central file no later than 30 days after receipt Copies of complaints must be maintained at the branch office Rule 4.9 Disciplinary action by other organizations Rule 9.3(b) Termination reporting of U-5s Rule 9.3(c) Termination filing of amended U-5s Rule 9.23 Customer complaints Rule 4513 Records of Written Customer Complaints Rule 4530 Reporting Requirements Rule 1070 Customer complaints Rule 401A Customer Complaints Rule 732 Customer Complaints Rule 341 Commentary.09 Termination of employment Form U5 Filing Rule 932 Customer complaints 3.4 Disciplinary Proceedings and Arbitration/Mediation Ensure that registered representatives understand the consequences of failure to comply with industry regulations Disclose to associated persons the effect of signing a pre-dispute arbitration clause Understand matters subject to arbitration Understand the difference between arbitration and mediation processes Ensure compliance with rules pertaining to suspended associated persons Investigations, Sanctions and Disciplinary Proceedings Rule 17.1 Disciplinary jurisdiction Rule 17.2 Complaint and investigation Rule 17.3 Expedited proceeding Rule 17.4 Charges Rule 17.7 Summary proceedings Rule 17.8 Offers of settlement Rule Judgment and sanction 32

34 Rule 8000 Investigations and Sanctions Rule 8210 Provisions of Information and Testimony and Inspection and Copying of Books Rule 8310 Sanction for Violation of the Rules Rule 8320 Payment of Fines, Other Monetary Sanctions, or Costs; Summary Action for Failure to Pay Rule 9200 Series Disciplinary Proceedings Rule 9300 Series Review of Disciplinary Proceeding by National Adjudicatory Council and FINRA Board; Application for SEC Review Rule 9800 Temporary Cease and Desist Orders Rule 960 Disciplinary Rules Rule 475 Prohibition or Limitation Rule 476 Disciplinary Proceedings Rule 8130 Retention of Jurisdiction Rule 9000 Series Disciplinary Rules Article V of AMEX Constitution Sec.1 Assistance of counsel permitted Sec.2 Delegation of disciplinary power Sec.4 Suspension or expulsion Sec.6 Retention of jurisdiction over former members Rules of Procedure in Disciplinary Matters Rules 1 through 12 American Stock Exchange Sanction Guidelines Overview, et. seq. NYSE ARCA Rules Rule 10 Disciplinary proceedings and appeals Arbitration and Mediation Procedures Chapter XVIII Arbitration Rule 2263 Arbitration Disclosure to Associated Persons When Signing or Acknowledging Form U4 Rule Administrative provisions Rule Industry and clearing controversies Rule Uniform code of arbitration Rule Mediation rules Rule 950 Arbitration Rule 347(a) Controversies as to Employment or Termination of Employment Rule 600 Arbitration Rule 636 Requirements When Using Pre-Dispute Arbitration Agreements With Customers Rule 638 Mediation Rule 600 Arbitration 33